World equities sold off in October, based on a range of concerns. The two most important were the potential impacts of higher bond yields, and the prospect of the U.S. or global business cycles running out of momentum. Higher bond yields have not only depressed returns from bonds but have also weighed on property and infrastructure. The likelihood is that both the U.S. and global expansions are still intact, but risk levels have risen at this late stage of the cycle, and further volatility can be expected. In New Zealand, the economy appears to be headed for a slower rate of growth, with some pressures on corporate profitability, and although the local share market has been a good performer in recent years, current valuations now look expensive in a slower growth context.
New Zealand Cash & Fixed Interest
Short-term interest rates have been steady, with the 90-day bank bill yield trading a little below 2.0%, reflecting the Reserve Bank of New Zealand's unchanged monetary policy. The official cash rate, or OCR, was yet again held at 1.75% at the latest review on Sept. 27.
Bond yields have moved up a bit from their recent low point in early September: the 10-year government bond yield had got as low as 2.52% (Sept. 4) but is now back up to close to 2.7%. The New Zealand dollar has been weak: year to date it has dropped 3.0% in overall trade-weighted value, mainly due to large declines against the Japanese yen (down 7.9%) and U.S dollar (down 7.7%).
It is likely that short-term fixed interest investments will be offering low returns for an extended period.
The listed property sector has been caught up in the wider equity market sell-off in October, but has nonetheless proved to be a relatively resilient defensive option. Year to date, the S&P/NZX All Real Estate index has eked out a small capital gain of 2.1% and provided a total return of 5.2%, slightly better than the 4.8% total return from the benchmark S&P/NZX50 index.
As in New Zealand, the A-REITs have also been a relatively effective defensive proposition. Year to date, the S&P/ASX200 A-REITs index is only marginally down (0.8%) in capital value, and has delivered a small 2.5% total return, outperforming the S&P/ASX 200's 0.7% total return.
The same has not been true of international property, however, which has continued to underperform global equities. Year to date the FTSE EPRA/NAREIT Global index is showing a 5.4% loss in terms of net return in U.S. dollars, significantly worse than the equivalent negative 0.8% return from the MSCI World index. By region, Japan and Germany have performed best, and emerging markets worst.
New Zealand shares have followed the global pattern—a gentle drift down from a peak in August or September (in New Zealand’s case Aug. 29), followed by a sharp sell-off over the week of Oct. 5-12. Since then, prices have stabilised, but have not recovered from the mid-October sell-off levels. Despite the October losses, share strength earlier in the year means that year to date the S&P/NZX50 index is still slightly ahead for the year, with a capital gain of 1.1% and a total return of 4.8%.
Australian shares have followed a similar trajectory, but limited progress earlier in the year means that the October losses have been the major driver of year-to-date performance. The S&P/ASX 200 index is currently down 2.6% in capital value for the year, although dividend income brings the total return marginally into the black, for a 0.7% gain.
International Fixed Interest
Bond markets have been in the spotlight as the proximate cause of the past month's global equity market weakness.
The outlook for this asset class remain challenging.
Undoubtedly the biggest development in financial markets in recent weeks was the sharp fall in equity prices in the first half of October. In the U.S., for example, the S&P500 index had been drifting gently downwards in any event—at its close on Oct. 9 it was down 1.7% from its peak on Sept. 20—but this was followed by a sharp decline of 3.3% on Oct. 10. Although there have been some rallies since then, notably a 2.1% gain on 16 October, they have not lasted, and at time of writing the S&P index is still below the level it dropped to following the big sell-off on 10 October.
The upshot is that year to date the latest weakness has unwound the gains made earlier in the year, and the MSCI World index is now down by 1.0% in capital value (in the overseas markets’ own currencies) and by 2.4% in U.S. dollars. Fortunately the 7.7% depreciation of the New Zealand dollar against the U.S. dollar has protected local investors from the worst effects of the overseas weakness.
By region, the U.S. continues to be by far the strongest. The S&P500 is still ahead for the year with a 3.1% gain, and the tech-heavy NASDAQ index is still up 8.2%, despite the big tech names taking some heavy hits in the latest volatility. Without the U.S. performance, world equities would have done significantly worse: the MSCI World in U.S. dollars, ex the U.S., is down 10.2%.
Among other major markets, only Japan has been relatively unscathed, with the Nikkei index marginally lower (down 0.7%) for the year. U.K. and European stocks have been weak, with, for example, the FTSE Eurofirst 300 index down 7.5%. Emerging markets, which had experienced a sell-off of their own even before October's setbacks, have been very weak, with the MSCI Emerging Markets index in U.S. dollars down 15.2% and the core BRIC economies (Brazil, Russia, India, China) down 14.7%.
There is still a reasonable chance of ongoing global business expansion and profit growth into 2019, or even beyond, which would form a usefully supportive backdrop for world equities. But it has become a more fragile prospect, vulnerable to a wider degree of risks.
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